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In a country not full of franchises, time to re-think business model?


Tao Xu

Illustration by Jonathan Hankin

Dateline:  Sydney, Australia

In early October, I flew Down Under to attend the International Bar Association’s annual conference. When I walked out of the Sydney Airport, I was greeted by a huge billboard advertising a pickup truck made by a Chinese car maker, Shanghai Automotive International Group (the joint venture partner of Volkswagen and GM in China, which never franchised its dealer network).

I hopped in an Uber (not a franchise), which took me to a Sheraton hotel (managed, not franchised, by Marriott/Starwood). The driver was a second-generation Hong Kong immigrant, with a side business on Airbnb (not a franchise).  

I then had lunch at the nearby Din Tai Fung location (excellent dim sum, but no plan to franchise in Australia last time they were asked). It was an unexpected start of my trip, given that Australia, by some count, is the most franchised country in the world.  Is it time to do some rethinking about the franchise model itself?

Is franchising under attack?

Outside of the hallways of Sydney’s International Convention Centre, one cannot help but wonder if franchising, especially cross-border franchising, is under attack.  

Franchise lawyers in recent years have focused on the intrusive government interventions—largely justified, but perhaps sometimes a bit overblown by the critics (yours truly included).  Are we paying enough attention to the onslaught from other (non-franchise) business models, especially in those newly developed markets (China and much of East Asia) and developing markets (Africa, Latin America and Southeast Asia), and how franchising can survive and indeed thrive in this new competitive landscape?

In discussions with the U.S. and international franchise lawyers on the sidelines of the conference and elsewhere, two observations have stayed with me.

First, multi-unit franchising is in vogue, with more and more opting for multi-unit franchising over master franchising.

But, as anyone who has watched “The Founder” can tell you, one of Ray Kroc’s insights was that in selling exclusive franchises for large markets, a franchisor would inevitably lose a degree of control over its franchise system. Kroc chose to stick to granting franchises one store at a time, and largely to “mom-and-pop” operators.  

Now, this would not work equally as well in a cross-border setting, but one has to wonder if we are overlooking this key insight in the rush to grant exclusive rights covering ever bigger markets to ever bigger multi-unit operators.    

In many international franchise transactions, the franchisors are putting the fate of an entire country or region (such as the Middle East) in the hands of a single multi-unit operator. 

The benefits are obvious—cheaper to support, easier to supervise, and less involvement required of the franchisor. But what about the risks?  Is putting all eggs in one basket always the right answer?

If master franchising (which shares, to a lesser degree, the same risk) is not the answer, is there a third way here? Will more franchisors, especially those well-capitalized ones, choose to establish a presence in a foreign market, prove the concept with company-owned pilot stores, and then franchise to a large number of smaller operators who will not be granted the entire province/country/region?

For most franchisors, maybe the more practical solution is to find balance in their relationship with the large multi-unit operators. Maybe it is to avoid the trap (and temptation of a larger initial fee) of giving away too much territory to an operator before any proven track record. Maybe it is to divide a big market into smaller markets and introduce several different multi-unit operators.  And maybe it is to introduce into the agreement mechanisms to deal with non-compliance that do not involve the nuclear option—termination.  

Questioning established practices

It turns out that drafting a sensible multi-unit franchise agreement requires reexamining many of the “established” practices from domestic franchising, and involves much more than just replacing the singular “store” with the plural “stores.”

Second, while “omni-channel” may have been one of retail’s favorite buzzwords for several years now, its adoption by the franchising industry is just beginning. It is commonly defined as a business model where all sales channels ranging from online, mobile, telephone, mail order, self-service and traditional brick-and-mortar establishments are integrated to provide retail consumers with a seamless experience.  

On a smaller scale, this means, for example, the development and implementation of mobile apps that not only allow customers to place orders in advance and pick up orders from franchised stores, but also have features such as the ability to reserve a spot in the wait line and place orders while his/her spot progresses in the wait line.  

Interestingly, many of the biggest industry “disrupters” started out online and are now moving offline. For example, the top two ecommerce operators in China, Alibaba/TMall and JD, have both adopted a franchise strategy to rebrand and support tens of thousands of small “mom-and-pop” convenience stores across the country in an effort to reach the 600 million Chinese consumers still unexposed to online retail.

In the last three years, Alibaba has poured about $30 billion into traditional brick-and-mortar retail companies. That is a remarkable testament to their belief in the potential of offline commerce, in a country where its biggest online shopping day (the “Singles Day”) is three times the sales on Black Friday and Cyber Monday combined.  

For franchise systems that already have an extensive brick-and-mortar footprint, this represents a huge opportunity to leverage their existing units.  For franchise lawyers, time has come to examine their whole approach to franchisor-franchisee relationships.

It may be time for the franchise lawyers to learn some new tricks.  How’s that for a New Year’s Resolution for 2018?

Tao Xu is a partner with DLA Piper in Reston, Virginia, and a colleague of our regular columnist Philip Zeidman, who is not writing this month. Contact him at 703.773.4181 or tao.xu@dlapiper.com

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